Question

Which of the following statement is TRUE regarding residual income?

	A.	Some investment opportunities that should be accepted from the viewpoint of the entire company could be rejected by a manager if the manager is evaluated on the basis of residual income.
	B.	Residual income can be used to compare the performance of divisions of different sizes.
	C.	Residual income is a better performance measure than return on investment.
	D.	Residual income motivates managers to pursue investments where the ROI associated with those investments exceeds the company’s minimum required return but is less than the ROI currently earned by the managers.

Answer 1

Answer is as follows:

Correct option : D

Residual income motivates managers to pursue investments where the ROI associated with those investments exceeds the company's minimum required return but is less thsn the ROI currently earned by managers.

Residual Income is calculated as Contribution (-) Cost of capital on investments. If residual income is used there is a greater chance that managers act in the best interests of the company rather than acting in their own divison's interests. Hence option D is appropriate among the given options.